Is Liberal Economics Dead, or about to Rise Up Like Phoenix?

The interesting headline written above is not just a key topic of almost all today’s discussions about economics and economic policy but also the issue of Enrico Colombatto’s exciting lecture which was held during an event organised by Liberalni Institut, Prague, on Wednesday 29th 2012. This event was the continuity of a series of seminars during which we try to find an answer to the question: How successful is liberalism today and what is its future?The event picked up from a previous lecture; “Will Italy follow Greece?” (The same main speaker) that Liberalni Institut with the support of Friedrich Naumann Stiftung organised on December 7th 2011.

After some words of welcome and introduction to the topic by Jiří Schwarz (Liberalni Institut, Prague), Professor Enrico Colombatto (ICER, IREF and Università di Torino) presented his view on the shape of free-market thinking and its development in an environment distorted by continuous governmental attempts to take care about millions of tax-payers via the regulation of freedom.

Of course, this development has brought many problems for free-market scholars. Pure roots of liberal economics, i.e. exchange and individual freedom to choose, are consistently destroyed by years of intensive misuse of words like liberal, liberalism and free market by the media and policy makers. From this point of view, people are not able to distinguish real causality between “power of exchange on the market” and “governmental interventions”. They think the recent crisis[1] is a result of free-markets, not the result of interventions. Nowadays issues, when big banks are “punished” for their wrong predictions and bad decisions[2]with the help of a three year low-interest credit bringing them the possibility for non-risk profit at an interest margin of about 4 – 5 p.p., has got nothing common with individual responsibility.

photo: Cody Allison

As Professor Colombatto said, the recent defensive position of the free market (classical liberal) economists began much earlier, 150 years ago, when classical liberals focused their attention to supply, i.e. to the production side, and neglected the demand side and individual behavior arising from the freedom to choose. Policy-makers were in favor of neoclassics, Walrasian economics rather than of Austrian scholars. Why? The view of neoclassical economists gave to politicians strong feelings that they can really manage an economy and human behavior as a whole by regulation and so they can create jobs for millions of voters, so for economists and last but not least for themselves.[3] So the main role in explanation of marginalist revolution was played by the neoclassicists. “Economics became a hard science, rather than a social science, a rationality of people has ruined free-market thinking,” explained Colombatto simply.

As Professor Colombatto presented, neoclassical economists were (and still are) clear, easier to understand, whereas Austrian’s world is taken as a dangerous jungle. But that is a mistake. It is not this sort of jungle, it is a structure built by free choice. Due to the fact that liberals focused their attention on advocating essence to the way of thinking, responsibility was forgotten, stand to the sidelines, and the democracy has degenerated into populism. It has “closed free-market” and supported rent-seeking.

On a recent example with obligatory deposit in a banking system Professor Colombatto showed what does “rationality” really mean in today‘s world, or better to be said that rationality and responsibility are not equal. We can characterize people‘s thinking by the sentence: “Rational behaving of the other man is something what seems rational to me.” For technocrats, rationality means behaving in favor of outcomes of econometric models. However, a stand of liberal economist is different. In the liberal world of free choice, rational behaving of individual is only one that is rational for this individual herself or himself. No models, no prejudices.

The next important Enrico Colombatto’s point was about World Wars as break-even points. Mainly World War I. was not just a life-changing experience for the whole society but also a monstrous challenge for all economists – task to be explained. Of course neoclassical economics and its technocratic approach had more tools with how to describe a situation then. Liberal individual responsibility from 18th and 19th century had been replaced by social responsibility[4]; race for political power, business influence and higher profit had begun. That, logically, meant a strong need for money. Taxpayers‘ money. Unfortunately, people were totally brainwashed by politicians past 50 years old and reassured the system is mutually beneficial and taxpayers are always on the winning side of the system, i.e. gain benefits from welfare state.

And, that is why a position of liberal economists is so difficult nowadays. We must “go back” and start to explain to the people that “individual responsibility matters” and that “anyone should take care about her- or himself, not expect it from the state”, despite the fact the temptation to interpret the recent crisis as a crisis of free market approach is very strong. Professor Enrico Colombatto developed very good proof for this statement. Imagine the situation, you have invested 100.000 € into Greek bonds. In the liberal world of individual freedom and responsibility, you as the owner of the bonds, well listen to this: “It is your fault. You have decided to buy the bonds, you will bear the loss.” On the other hand, in the world of social responsibility, the owner will be confused: “It is a market failure, you lost your money however it is not your mistake. Such a bad world! Poor man, you must be compensated.” Which world will you as the owner listen to?

By Colombatto, the only way how to solve the problem and efficiently explain the merit of this issue is to privatize the educational system (because nothing is free of charge and education is a basic public good, if you pay taxes and you send your children to private school, you are paying your tuition twice), and also to show the cost of social responsibility. The essences of free-market economics are choice and exchange, its counterparts are methodological individualism, subjectivism and individual responsibility. Without understanding this basement of free thinking, no progress can be made.

Enrico Colombatto[5] is Professor of Economics at the University of Turin and Director of the International Centre for Economic Research (ICER) in Turin and Prague, Italy. He received his Ph.D. in economics from the London School of Economics, and he is a Member of the Council of Public Policy, Munich and Berlin, and Institut de Recherches Economiques et Fiscales.

[1] Strongly recommend to read Enrico Colombatto‘s paper THE BIRTH AND FAILURE OF THE EMU PROJECT that was published in 1998 (!!!) in the Journal des Economistes et des Etudes Humaines, volume 8, number 2/3, June-September 1998, pp219-238.

[3]There was a sharp difference between neoclassicals and Austrian’s view: “No politician can really influence an economy, all processes in economy come from individuals, their preferences, their freedom of choice and exchange on the market”)